Asia: No Safe Haven in Financial Panic
A commentary in the VoxEU Debate: Macroeconomics
The violent swings across Asian financial markets—largely in tandem with the US and other major global markets—have shredded any remaining myths about “decoupling Asia.”
In spring 2007, I argued in Asian Development Outlook 2007 (ADB, 2007) that “decoupling”—the popular notion back then that Asia appeared little affected by the fate of the US economy—is myth. Despite much hype about fast growing Asian economies and rising demand, evidence suggests that they remain sensitive to the global business cycle. What’s more, tightened global financial links appear to underpin this macroeconomic interdependence through cross-border correlations of asset prices and related market sentiment.
With the US financial crisis under intensive care, the odds of a recession in the US and globally are rising. Effects on Asia will be a sharp drop in global demand (particularly from the US), a rise in risk premiums and a drop in available credit, and changes in the direction of monetary policy rates and long-term interest rate adjustments in major industrial economies.
It is undeniable that Asia has made remarkable progress in regional economic and trade integration. One tenet of the “decoupling” thesis is that Asia increasingly trades with itself and less with the US. Today, about 40% of all goods leaving Asia’s ports are headed for other Asian destinations. The US market now accounts for 15% of Asia’s total exports, down from 20% just 5 years ago. Also, while Asia accounts for about a mere 11% of world GDP in real USD terms (18% on a purchasing power parity basis), its share of incremental income globally is growing rapidly. Asia posted an annual average growth rate of 8.1% over the past 5 years—or nearly one fourth of total global growth.
Still, Asia remains tied to the global business cycle—both structurally and cyclically. Production networks across Asia have given strong momentum to regional economic and trade integration since the 1990s. But regional trade integration is tightly linked to global business networks. Growing intra-Asian trade is driven to a large extent by shipments of intermediate goods eventually consumed outside the region. Final demand for Asian goods remains with the world’s major industrial countries. For example, more than 60% of Asian exports are ultimately headed for G3 economies (after tracking the ultimate destination of trade in intermediate goods). Recently, many also suggest that financial globalization provide more channels for rapid transmission in case of a global shock.
Should the world economy suffer a severe slowdown as a consequence of the global financial crisis, there is little doubt Asia would be badly affected. As the fallout from the credit crunch deepens, risks are plenty. International financial conditions will likely worsen further and sour the investment climate. In the crisis aftermath, emerging Asian financial assets will continue to be re-priced, with the region facing a reversal of capital flows. Volatility in the movement of foreign portfolio investments—short-term funds placed in stocks, bonds, and banks' overseas borrowing—is another significant risk. Asset price volatility in the region has already made a visible dent in investor confidence along with rising risk premiums in offshore funding markets. Contagion may affect Asian economies and financial systems more seriously if tightening credit conditions and financial instability weigh in on broader economic activity regionally as well as globally.
Asia is no safe haven in financial panic. What we witnessed in the post-Lehman Brothers period is a solemn reminder that we are in this together. However, recoupling is not to dispute that Asia is still the best bet as the world’s fastest-growing region over the next few years. While the signs of spillover from the financial crisis are becoming evident in Asian financial markets, the region’s relatively healthy internal growth momentum remains a hope. Cyclical co-movements aside, Asia’s long-term growth trajectory was long ago diverted away from business cycles in major industrial countries—by the strong dynamics of economic catch-up based on rapid industrialization and building infrastructure. Couple with relatively resilient local credit conditions in support of domestic demand, this pattern should help the region skirt the worst effects of the current financial storm, thus ameliorating the effects of the global economy falling into recession.
What Asia does can certainly help forestall a severe global recession and arrest the spread of financial panic. Macroeconomic interdependence between Asia and major industrial economies has far-reaching implications for the region as well as the global economy. The rise of Asia is inevitably reshaping the global economic and financial scene. While Asian economies continue to grow, financial market development and integration has not kept up. Asia’s contribution to global demand remains far below its income—as it has continued to run sizeable current account surpluses. While G3 economies consume nearly as much as they produce, Asia consumes only about 70%. And it is this persistently large global imbalance that is behind the current global financial mess. Increasing growth in domestic demand by promoting economic efficiency and flexibility is key to keeping Asia on its high growth trajectory. More importantly, it helps reduce global imbalances and could ultimately restore confidence in global financial markets.
Greater global integration necessitates closer global policy cooperation during crises. With its growing influence on the global economy, Asia must take greater responsibility as a cooperative and responsible partner in the global community. In return, Asia will have a stronger voice in global decision making.
Office of Regional Economic Integration
Asian Development Bank